Scott, Financial Accounting Theory, 7th Edition Instructor’s Solutions Manual Chapter 2
1. Cash = $1,210.00 cash flow – 72.60 (605 × 0.12) interest paid on
bonds = $1,137.40
4. Capital stock is issued in the amount of cost of asset less proceeds
of bonds:
)56066(100,3
]
10.1
60560.72
10.1
60.72
[100,3
2
+−=
+
+−
28
17. a. Expected present value of North Ltd’s asset on August 1, 2015 and July
31, 2016:
( ) ( )
78.28226.2913.034.84879.8737.0
03.1
300
03.1
300
3.0
03.1
900
03.1
900
7.0
22
0
+++=
++
+=PA
03.699
38.8765.611
=
+=
North Ltd.
Scott, Financial Accounting Theory, 7th Edition Instructor’s Solutions Manual Chapter 2
Balance sheet
As at July 31, 2016
Cash (900 – 15 – 50) $835.00 Bank loan $500.00
Shareholders’ equity
North Ltd.
Income Statement
For the year ended July 31, 2016
Expected net income (accretion of discount) (877.70 × .03) $26.33
Abnormal earnings:
Scott, Financial Accounting Theory, 7th Edition Instructor’s Solutions Manual Chapter 2
Accretion of discount $1,377.70 × 0.03 = $41.33
Less interest accrued on bank loan $500 × 0.03 = 15.00
26.33
Abnormal earnings, as above 180.00
Net income $206.33
b. The implied revenue recognition timing is on a present value basis. That is,
discounted expected future revenue is capitalized into capital asset on the
c. Net income for the year ended July 31, 2016 on a historical cost basis:
Sales (900) minus amortization expense (1,377.70/2 = 688.85) gives net
31
18. a. Under ideal conditions, the amount paid for an asset equals its expected
present value.
Expected present value of Electro’s assets on January 1, 2015:
Present value of assets on Jan. 1, 2016 also required to answer part b:
04.932
01.23303.699
03.1
600
4.0
03.1
1200
6.0
1
=
+=
×+×=PA
b. Electro Ltd.
Balance Sheet
As at December 31, 2015
Cash (900 – 60) $840.00 Shareholders’ equity
Electro Ltd.
Income Statement
For the year ended December 31, 2015
Scott, Financial Accounting Theory, 7th Edition Instructor’s Solutions Manual Chapter 2
32
c. The main reason is that ideal conditions do not prevail in practice. The
high relevance of present value–based accounting remains. However, lack of
ideal conditions creates concern about reliability of present value–based
19. a. Under ideal conditions, the amount paid for an asset equals its present
value:
Scott, Financial Accounting Theory, 7th Edition Instructor’s Solutions Manual Chapter 2
33
95.218
55.5540.163
)50.4434.94(4.0)00.17834.94(6.0
)
06.1
50
06.1
100
(4.0)
06.1
200
06.1
100
(6.0 22
0
=
+=
+++=
+++=PA
b.
QC Ltd.
Statement of Net Income
For the Year ended December 31, 2016
Accretion of discount (232.08 ×.06) $13.92
Abnormal earnings
Expected cash flow (0.6 × 200 + 0.4 × 50) 140.00
c.
QC Ltd.
Balance Sheet
As at December 31, 2016
Scott, Financial Accounting Theory, 7th Edition Instructor’s Solutions Manual Chapter 2
34
Current asset Capital stock $218.95
35
20. Note: In this problem, state probabilities are not independent over time. Part b of
this question requires calculations not illustrated in the text.
a. The cost of the machine equals its present value as at time zero:
( )
( ) ( )
[ ]
( ) ( ) ( )
[ ]
( )
800,275.0800,125.0
08.1
1
500,1
08.1
1
700,210075.0200,160025.0
08.1
1
750750
08.1
1
000,390.0000,110.075.0000,340.0000,160.025.0
08.1
1
000,325.0000,175.0
08.1
1
2
2
2
0
×+×+×=
+++++=
×+×+×+×+
×+×=PV
67.666,1$
08.1
800,1
08.1
==
b.
Conditional Ltd.
Scott, Financial Accounting Theory, 7th Edition Instructor’s Solutions Manual Chapter 2
36
Income Statement for Year 1
(No major failure)
Accretion of discount (expected net income) $286.01
( )
01.286$08.10.575,3 =×
Abnormal earnings
Year 1:
Year 2:
Original expected cash flows:
Revised expected cash flows resulting from
year 1 state realization:
c.
Conditional Ltd.
Balance Sheet as at End of Year 1
(No major failure)
Financial Asset Shareholders’ Equity
Capital Asset, Retained Earnings
Scott, Financial Accounting Theory, 7th Edition Instructor’s Solutions Manual Chapter 2
37
38
20. a. Present value at January 1, 2015:
000,5
000,6
000,
7++
Present value at December 31, 2015, based on revised estimates:
000,6
500,6 +
ABC Ltd.
Income Statement from
Proved Oil and Gas Reserves
For the Year Ended December 31, 2015
Accretion of discount (15,078.89 × 0.10) $1,507.89
Changes in estimates:
Shortfall in 2011 revenue
(7,000 – 6,500) ($500.00)
Increase in present value
Increase in present value of future revenue is calculated as follows:
2
10.1
10.1
Scott, Financial Accounting Theory, 7th Edition Instructor’s Solutions Manual Chapter 2
39
Note: While not required as part of the question, ABC’s balance sheet as at
December 31, 2015, is:
b. Possible concerns arise from the low reliability of reserves estimates, and
include:
• Reserve quantity estimates are subject to error.
22. a. HL Oil & Gas Ltd.
Income Statement from Proved Oil and Gas Reserves
For the Year 2015
Accretion of discount $700
Abnormal Earnings:
Scott, Financial Accounting Theory, 7th Edition Instructor’s Solutions Manual Chapter 2
40
b. The reason derives from concerns about reliability of the reserves
c. Again, the reason derives from reliability concerns. Allowing each firm to
23. a. FX Energy, Inc.
Income Statement for 2015
Abnormal earnings:
Present value of additional reserves proved
Scott, Financial Accounting Theory, 7th Edition Instructor’s Solutions Manual Chapter 2
41
b. RRA net income of $2,930 differs from the historical cost–based loss of
$5,245 because of differences in the timing of revenue recognition. Under
c. The reason derives from concerns about reliability of the reserves
estimates. Information about all reserves, and their expected future cash flows,
d. Again, the reason derives from reliability concerns. Allowing each firm to
choose its own discount rate opens up the possibility of manager bias, whereby
24. a.
Moonglo Energy Inc.
Income Statement for Proved Oil and Gas Operations
For year 2015
RRA Basis
Accretion of discount $125
Note: Items on the statement of changes in proved reserves not included in the
income statement above ((456), (4), 629) represent cash receipts and
Sales (456 + 4) $460
Development costs incurred in year (629)
Amortization “income” – increase in
balance of proved reserves in
See Notes 8 and 11 of this chapter.
Scott, Financial Accounting Theory, 7th Edition Instructor’s Solutions Manual Chapter 2
43
b. Profit on a historical cost basis differs from RRA net income because of
different bases of revenue recognition. Under RRA, income is recognized as
c. RRA is more relevant, since it records revenue earlier than historical cost.
If a balance sheet was prepared on an RRA basis, inventory of proved oil and
gas reserves would be valued at average selling prices for the year, rather than
Scott, Financial Accounting Theory, 7th Edition Instructor’s Solutions Manual Chapter 2
44
25. a. The most relevant point of revenue recognition is at the beginning of the
operating cycle. For a manufacturing firm, this would be as raw materials and
Indeed, one could envisage revenue recognition even earlier than this. For
example, for a manufacturing firm, revenue could be recognized when acquisition
b. Points to consider:
• Lucent has an incentive to recognize 2000 revenue early to try to prevent
its reported net income from falling below 1998 and 1999 levels.
Scott, Financial Accounting Theory, 7th Edition Instructor’s Solutions Manual Chapter 2
45
c. Ownership interest in the customer increases problems of reliable
estimation of the amounts that will ultimately be collected. The vendor’s revenue
26. a. Relevant information is information that enables the prediction of future
firm performance, such as future cash flows. Early revenue recognition
b. Reliable information is information that faithfully represents the firm’s
financial position and results of operations. When significant risks and rewards of
Scott, Financial Accounting Theory, 7th Edition Instructor’s Solutions Manual Chapter 2
46
arms–length transaction, the amount of sale is reliable due to lack of possible
manager bias.
c. Under ideal conditions, revenue is recognized as production capacity is
acquired, since future revenues, or expected revenues, are inputs into the
present value calculations. The balance sheet valuations of capital assets
27. a.
Manulife Financial Corporation
Income Statement, Embedded Value Basis
Year Ended December 31, 2011